can my sister legally regain custody of her children while on home confinement?

There is no known case directly "on point" (controlling this question).  Looking at things more generally, your sister can certainly file a motion protesting the ongoing violation of the agreed terms, and make the request for the kids to live at home.  Whether such a request would be granted depends on a lot of facts not revealed by your question -- including what caused the kids to go with the grandparents in the first place, what the criminal matter was and whether it related to the kids or their welfare, and all of the other kids of factors considered for custodial placements and changes.  To see those, refer to the materials posted at http://willicklawgroup.com/child-custody-and-visitation/.